Tax incidence
Economics 001
Principles of Microeconomics
Professor Arik Levinson
DN: Nominal incidence, or statutory incidence, is borne by those
who physically pay the tax. It's what the law says.
•Lecture 7
–Tax incidence
DN: Economic incidence is borne by those who suffer economic
loss as a result of the tax.
Example: A $3.00 cigarette tax -Suppliers bear the nominal incidence
Example: A $3.00 cigarette tax -Consumers bear the nominal incidence
Dtax D
Stax
P
$3.00
PC =P2
P
S
Economic Incidence:
Consumers pay
PC-P1
Suppliers pay
P1-PS
P1
PS
S
Economic Incidence:
Consumers pay
PC-P1
$3.00
PC
Suppliers pay
P1-PS
P1
PS =P2
D
Q2 Q1
Cigarettes
The nominal incidence is irrelevant to
the economic incidence.
Q2 Q1
Cigarettes
Tax Division and
Elasticity of Demand
• Two Extremes
– Perfectly inelastic demand--buyer pays
• Example: Insulin
– Perfectly elastic demand--seller pays
• Example: Pink marker pens
1
S
2.20
S + tax
Buyer pays
entire tax
S
2.20
Perfectly Inelastic
Demand
2.00
Sales Tax and the
Elasticity of Demand
Price (dollars per dose)
Price (dollars per dose)
Sales Tax and the
Elasticity of Demand
Perfectly Inelastic
Demand
2.00
D
D
100
Quantity (thousands of doses per day)
100
Quantity (thousands of doses per day)
Sales Tax and the
Elasticity of Demand
Sales Tax and the
Elasticity of Demand
S + tax
Price (cents per pen)
Price (cents per pen)
S
S
1.00
1.00
Perfectly Elastic
Demand
Perfectly Elastic
Demand
Seller
pays
entire
tax
0.90
0.90
1
1
4
Quantity (thousands of marker pens per week)
Tax Division and
Elasticity of Demand
• The division of the tax depends upon
elasticity.
– The more inelastic the demand, the more the
buyer pays.
– The more elastic the demand, the more the
seller pays.
4
Quantity (thousands of marker pens per week)
Tax Division and
Elasticity of Supply
• Two Extremes
– Perfectly inelastic supply — seller pays
• Example: water from a mineral spring
– Perfectly elastic supply — buyer pays
• Example: sand used to make silicon used by
computer chip makers
2
Price (dollars per bottle)
Price (dollars per bottle)
Sales Tax and the
Elasticity of Supply
S
50
Perfectly Inelastic
Supply
45
Sales Tax and the
Elasticity of Supply
S
50
Perfectly Inelastic
Supply
Seller pays
entire tax
45
D
D
100
Quantity (thousands of bottles per week)
100
Quantity (thousands of bottles per week)
Sales Tax and the
Elasticity of Supply
Price (cents per pound)
Price (cents per pound)
Sales Tax and the
Elasticity of Supply
Perfectly Elastic
Supply
11
10
S
Perfectly Elastic
Supply
11
S + tax
buyer pays
entire tax
10
S
D
3
D
5
Quantity (thousands of pounds per week)
Tax Division and
Elasticity of Supply
3
Tax incidence in sum...
Suppliers pay nominal incidence...
Suppliers pay nominal incidence...
S
D
P
P
S
• The division of the tax depends upon
elasticity.
S
D
S
– The more inelastic the supply, the more the
seller pays.
Q
Consumers pay nominal incidence...
– The more elastic the supply, the more the buyer
pays.
5
Quantity (thousands of pounds per week)
D
P
Q
Consumers pay nominal incidence...
P
D
S
D
S
D
Q
Q
3
Deadweight Loss
DN: Deadweight Loss of a Tax =
Social Costs above and beyond Tax
revenue
Deadweight Loss
P
Stax
CS
S
$tax
PC =P2
P1 Tax Revenue
P
PS
P
PS
PS
Q2
Social Cost
Deadweight Loss
D
Q1 Cigarettes
4